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SALT Blog/Blawg

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The History of the SALT Deduction

As Democrats continue to finalize their now-$1.75 trillion tax-and-spending plan, the Federal income tax deduction for state and local taxes (the “SALT deduction”) has once again reared its head in partisan politics playing out in deliberations over a major piece of legislation.  As prior blog installments have discussed, the SALT deduction cap became a political lightning rod in 2017 when a Republican-controlled Congress passed the Tax Cuts & Jobs Act.  Four years later, here we go again.  Interestingly, for the SALT deduction’s first 150 years, it was not a partisan issue.  It has become so only in about the last 5 years.  So what happened?  Here’s the nutshell version of the deduction’s history and some thoughts on how we got here: 

The United States’ first income tax was enacted in 1861, and tweaked in 1862.  Both versions contained only one deduction; and, you guessed it, it was the SALT deduction!  A recently minted political party called the Republican party controlled Congress and a Republican-party President occupied the White House for the first time (a 6’ 4” fellow named Abraham Lincoln).  Records of why the SALT deduction was included in the first income tax are scarce, but there are documented statements by Congressional Republicans that may support two justifications.  The first was federalism and keeping the Federal tax out of the orbit of State levies.  The second was double taxation: preventing the Federal government from taxing a dollar that the States had already taxed.  There is no record of political discord over the SALT deduction.  This first income tax, in large part a stopgap to fund the Civil War and its aftermath, expired under its own terms in 1872. 

In 1894, Congress reinstated the income tax, along with the SALT deduction.  This time Democrats controlled both Congress and the White House, with Grover Cleveland at the reigns.  There is no record of a debate about the SALT deduction’s inclusion but there is at least one comment by a Congressional Democrat that taxes (without specifying which taxes) would no doubt be deductible.  In any event, the 1894 income tax was short-lived.  In 1895, in the seminal case, Pollock v. Farmers’ Loan & Tr. Co., a divided Supreme Court (with four separate dissents) struck down the income tax on grounds it violated the constitutional prohibition against direct taxes not apportioned among the States in proportion to their relative populations.  Not an entirely auspicious start for our Nation’s income tax system.  It was back to the drawing board. 

Enter the 16th Amendment to the US Constitution.  In 1909, Congress voted in favor of the 16th Amendment, and following a four-year process the States ratified it in 1913.  The Amendment – then and now – authorizes Congress to “lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States.”  Upon ratification, Congress re-minted the federal income tax in the 1913 Revenue Act.  The new income tax contained more deductions than the pre-16th Amendment versions and continued a similarly worded SALT deduction for “all national, State, county, school, and municipal taxes paid within the year, not including those assessed against local benefits.”  There is no record of debate about the SALT deduction directly in connection with the 1913 Revenue Act.  In the debate over the 16th Amendment, concerns of federalism were voiced but nothing direct and explicit about the SALT deduction exists in recorded history. 

From this point forward (across more than 50 different Congresses and more than 50 different tax acts), the SALT deduction, in some form, has been a feature of the Federal income tax.  But the deduction has not remained static over the next century, nor has it been regarded as entirely sacrosanct.  The SALT deduction has mutated through the years, both by direct modifications and indirectly through structural changes to the tax code.  For example, in 1944 Congress introduced the standard deduction, which while not directly changing the SALT deduction, had the effect of limiting its pertinence to taxpayers who chose to itemize their deductions.  In 1964, Congress directly altered the SALT deduction: it scaled back the types of state and local taxes that were deductible; limiting it basically to income, property and sales taxes.  There is no indication that these changes to the deduction were wedge issues between political parties.

In the more modern era, Congress impacted the SALT deduction in the Tax Reform Act of 1986.  They removed sales taxes from the list of deductible State and local taxes.  Congress also enacted the alternative minimum tax (“AMT”), which required high-income taxpayers to calculate their tax liability using an alternative method (the AMT) which, if greater than the regularly computed income tax liability, they were required to pay.  If paying under the AMT, the taxpayer is effectively prevented from claiming the SALT deduction.  Then, in 1990, Congress enacted phase-outs (also known as the “Pease limitation”) under which taxpayers with adjusted gross incomes exceeding certain specified thresholds were required to reduce the overall amount claimed in itemized deductions, including the SALT deduction.  Then, in the American Jobs Creation Act of 2004, Congress reinstituted the deduction for State and local sales taxes for taxpayers that elected to deduct sales taxes in lieu of the deduction for State and local income taxes. 

During the modern era outlined above, several policy issues in connection with the SALT deduction emerged.  Most notably, in connection with the Tax Reform Act of 1986, policy wonks at Treasury began pointing out the disproportionate benefit the SALT deduction bestowed upon high-income taxpayers residing in high-tax States.  It pointed out that two-thirds of taxpayers who do not itemize deductions receive no value from the SALT deduction.  It also raised that even itemizing taxpayers receive relatively little benefit from the deduction unless they reside in a high-tax State.  More on the regressive nature of the deduction in a bit.  Counteracting these policy concerns were the continued resolve of many legislators that the SALT deduction was a cornerstone of Federalism, and moreover that it was an exceedingly popular feature in the tax code and should be preserved.  Congress actually passed a “Sense-of-the-Senate” that emphasized these points.  The Sense-of-the-Senate was co-sponsored by a large and broad bipartisan coalition.  There were no discernable divisions between Democrats and Republicans; between high-tax and low-tax States; or between “Blue,” “Red,” and “Purple” States.  The SALT deduction was a unifying rather than dividing subject matter.  Its guardians were genuinely bipartisan. 

In 2017, however, everything changed.  A Republican-controlled Executive and Legislative Branch pursued major and transformative changes to the Internal Revenue Code that met strong headwinds from Democrats.  As a relatively minor part of the overall plan (minor from a revenue perspective relative to the overall package), the cap on the SALT deduction was proposed.  Core tenets of the reform effort were tax simplification and rate reduction.  It may have seemed the right time to take on the popular SALT deduction because it was part of a broader deal that lowered taxes for most individuals by reducing marginal rates and increasing the standard deduction.  The vast majority of taxpayers would receive a higher overall deduction level even without the SALT deduction.  Such trade-off, it seems, most Congressional Republicans could stomach.  You might think that scaling back a regressive deduction (one that benefits higher earners), would also be acceptable to Congressional Democrats.  But, you would be wrong.  The cap was viewed as a slap in the face to many Democrats, an effort to harm States that did not vote Republican in the preceding election. 

It probably didn’t help that stated justifications from leading Republicans for capping the SALT deduction may have sounded like they were targeting “Blue” States.  Then-Speaker of the House Paul Ryan stated that “[p]eople in states that have balanced budgets, whose state governments have done their job and kept their books balanced and don't have massive pension liabilities, they're effectively paying for states that don't.”  Another member of Congress added that the cap would not be “as good” for “New Jersey, New York, and other states that have horrible governments.” Then-Treasury Secretary Mnuchin “hope[d]” that the SALT deduction cap would “send[ ] a message to the state governments that, perhaps, they should try to get their budgets in line” and implied that “13 or 14% taxes” are unacceptably high.  And President Trump stated that the new law “creat[es] an incentive” for state politicians to “do a good job of running [their] state.”  The messaging that the SALT deduction was causing residents of fiscally responsible States to subsidize wealthy residents in States with bigger governments and higher taxes were seemingly directed at “Blue” States.  Statements like these may have fanned some flames.

Of course, who started it is beside the point.  What’s significant is that the SALT deduction cap dominated the political rancor surrounding the 2017 legislative agenda to reform the income tax system, and took on a life of its own.  Congressional Democrats (most vocally those from high-tax “Blue” States) pilloried the SALT deduction cap to no end.  Notably absent from the predominant public discourse were the concepts of Federalism, double-taxation, and the regressive qualities of the SALT deduction.  It was simply “Blue” versus “Red.”  Policy took a backseat to partisanship.    

Ever since the SALT deduction cap was enacted in 2017, critics of the cap have campaigned to reverse it.  It has become a wedge issue.  Although critics hail from every walk of life and political stripe, the charge has been led most prominently by the Democratic Party and a handful of high-tax “Blue” States.  In the past year, Democrats, with control of both the Legislative and Executive branches, have introduced bills to repeal the SALT deduction cap, although to no avail so far.  An obstacle has been the regressive nature of a repeal.  HR 5377, introduced by a New York Democrat, would have removed the SALT deduction cap for anyone with an adjusted gross income of less than $100 million (yes, $100 million, that’s not a typo).  The Congressional Budget Office estimated the repeal would cost up to $88.7 billion per year.  A study by the Center for American Progress estimated that more than 50% of the benefit of the repeal would go to the wealthiest 1%, and 97% of the benefit would go to the top 20% percent.

More recently, Democrats have revisited what to do with the SALT deduction cap in connection with the $1.75 trillion tax-and-spending plan, the work of which remains in progress at the time of this writing.  Notably, the front among Democrats does not seem as united as it once was around the SALT deduction.  Senators such as Bernie Sanders, who continues to have an influential following and chairs the Budget Committee in the Senate, has decried the repeal of the SALT deduction cap as “beyond unacceptable.”  There has been discussion about making the repeal less regressive by limiting the taxpayers to which the repeal would apply, or by raising the cap but not altogether eliminating it.  There is also the more practical issue of cost.  How to pay for the $1.75 trillion spending plan is still in flux.  Repealing the SALT deduction cap would add to revenue-raising offsets necessary to fund the package.  Ideas are circulating such as temporary repeals to reduce the 10-year budget window’s estimated cost of the repeal.       

Of course, this latest chapter is still being written.  Many scenarios remain possible.  Including the possibility that alliances will shift and policy rather than partisanship will determine the fate of the storied SALT deduction.

Categories: SALT, SALT Update
  • Peter A. Lowy

    Peter A. Lowy, a shareholder in Chamberlain Hrdlicka’s Houston office, is best known for his tax controversy work and deep experience in the energy sector. He also advises corporations and other taxpayers in a broad spectrum of ...